Subsequent to entering into a petition for relief under Chapter 11 until a plan of reorganization is confirmed, prepetition liabilities that are subject to compromise are separate and distinct from the ongoing operations of the debtor.

Such obligations should not be otherwise reclassified into Liabilities Held for Sale or Liabilities of Discontinued operations, unless such liabilities become not subject to compromise and the debtor has the ability to transfer the obligations in the sale transaction.

ASC 852, Reorganizations, requires separate reporting of reorganization efforts from results of ongoing operations and the segregation as Liabilities Subject to Compromise of pre-Chapter 11 filing obligations that the filing company (“debtor”) expects to compromise.

ASC 852 also defers to guidance in ASC 205 when the effect of the reorganization effort results in the cessation or sale of a business component that meets the requirements for discontinued operations presentation. On its statement of financial position, ASC 205 requires the reporting entity to present separately the assets and liabilities of the disposal group classified as held for sale.

The author points out that in those situations where a company has reported Liabilities Held for Sale or Liabilities of Discontinued Operations at the time it files for Chapter 11 protection, the prepetition obligations classified as such should be analyzed and, if subject to compromise, be reclassified accordingly.

It also notes the other factors pointing to not reclassifying portions of Liabilities Subject to Compromise to Liabilities Held for Sale or Liabilities of Discontinued Operations are the current classification of the latter two categories of liabilities.

This article first appeared in the December/January 2010 issue of the AIRA Journal.

James M. Lukenda is a Managing Director at Huron Consulting Group. Mr Lukenda has assisted clients with troubled debt restructurings, mergers, acquisitions and dispositions, litigation and claims analysis, fraud investigations, and other financial consulting and bankruptcy assignments for over 30 years.